Our Insights

Will regulatory change help boost cross-border fund distribution?

Simplifying the process for AIFs to market products across member states is key

The European Union's (EU) Alternative Investment Fund Managers Directive (AIFMD) has been credited with strengthening investor protections and improving transparency in the asset management industry, yet cross-border distribution continues to be an area in need of reform.

Key insights

  • The AIF marketing passport has resulted in increased distribution but member state gold-plating and restrictive pre-marketing rules have made it harder for firms to sell cross-border
  • The NPPRs available to non-EU AIFs are also arbitraging, making it more challenging for firms to sell into multiple EU markets leading to calls for better standardization of the NPPRs
  • The depositary framework and regime for preserving market stability is robust, yet minor changes could be introduced in the future

Following the European Commission's (EC) release of a report in June 2020, which provided an assessment of AIFMD's progress to date, the EC subsequently launched a follow-up public consultation in October 2020 asking for industry comment on how the alternative investment fund (AIF) market could be made more competitive, effective and efficient in a way that does not undermine EU financial stability.1

Shifting away from gold-plating cross-border distribution

Efforts to make it easier for EU AIFs to freely passport their investment products on a cross-border basis have yielded some success. The EC notes that cross-border distribution of AIFs almost doubled between June 2017 and October 2019, increasing from three percent to 5.8 percent.2 Nonetheless, it simultaneously concedes that there are barriers to frictionless distribution. A number of member states have used gold-plating or introduced diverging marketing requirements, or both.3  The tightening up of the rules around pre-marketing, which put restrictions on the time limit for reverse solicitation, has impacted the ability of AIFMs to distribute cross-border.4

Non-EU AIFs also face obstacles when promoting their funds across member states. The absence of a marketing passport for non-EU AIFs means these entities are subject to national private placement regimes (NPPRs). NPPRs, however, are not consistent, so non-EU AIFs must comply with a range of different local rules depending on which countries they are distributing into, adding to their overheads at a time of steep margin compression.5

Non-EU AIFs also
face obstacles
when promoting
their funds across
member states

Industry groups have repeatedly argued that NPPRs need to be harmonized in order to make it simpler and more cost-effective for non-EU AIFs to access EU investors. Alternatively, the marketing passport could be made available to equivalent non-EU countries, as was the original intention under the AIFMD. However, the Brexit vote put these plans on hold, and very little has been mentioned about extending the passport beyond the EU.6

The risks of removing NPPR

Not everyone supports relinquishing NPPRs in favour of providing the marketing passport to non-EU AIFs. According to international law firm Sidley Austin, the removal of NPPRs, “would create significant difficulty for US and other non-EU AIFMs that currently rely on the NPPRs to market their funds into the EU. Non-EU AIFMs are unlikely to want to use the AIFMD passport if so activated because that entails the AIFM becoming fully authorized and regulated under the AIFMD, with its attendant obligations including regulatory capital, single depositary and remuneration rules.” 7

Potential revisions to the depositary regime

Industry groups
have repeatedly
argued that
NPPRs need to
be harmonized

Depositaries will continue to serve their purpose insofar as protecting investors. However, the EC also accepted clarifications may be needed when AIFMs use tri-party collateral management or in scenarios where the central securities depository (CSD) is acting as custodian.The EC added that the ongoing absence of a depositary passport went against the principles of the Single Market.9 Moreover, it expressed concern about the lack of service providers–who could act as depositary–in certain smaller markets, something which could lead to concentration risk at a single depositary.10

Protecting the integrity of the financial system

On mitigating systemic risks, the EC reported that stakeholders supported the rules permitting national competent authorities (NCAs) to impose leverage limits or suspend redemptions at AIFMs during crises, although greater member state harmonization and cooperation may still be required in this area, especially if redemption suspensions have cross-border implications. The EC also highlighted the current gross and commitment methods for measuring leverage at AIFMs were adequate. Changes could be introduced once the Financial Stability Board (FSB) and IOSCO (International Organization for Securities Commissions) reach a conclusion on this matter.11

By improving the AIFMD framework, it should become more straightforward for asset managers to raise funds

By improving the AIFMD framework, it should become more straightforward for asset managers to raise funds and then channel capital into companies and projects, thereby strengthening the real economy–a key objective of the CMU.12

While there are likely to be further discussions between the EC and the industry, the introduction of a depositary passport and a move away from gold-plating NPRs, in line with the principles of the Common Market, may be the end result. Developments will be closely watched by market participants.

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